How to Buy a Foreclosed Home

How to Buy a Foreclosed Home

Foreclosure listings are attractive to both house hunters and investors. Buying a foreclosed home can be a great opportunity to snap up a house at below-market prices.

However, this strategy is not without risks and challenges. If you’re planning to buy a foreclosure home, take the time to learn about the process and how to avoid common mistakes.

What is Foreclosure?

Foreclosure happens when a homeowner defaults on their mortgage payments and the lender takes possession of the property. The lender typically sells the home to recover the outstanding loan balance, and they commonly sell the home at a discounted price.

Sometimes foreclosure homes for sale are listed quite far below market value, but that’s not always the case. Prices ultimately depend on market conditions, the condition of the property, and competition among buyers.

Foreclosure usually proceeds in three stages, which can determine the best strategy for bidding on them.

Pre-Foreclosure

Pre-foreclosure happens when the homeowner has fallen behind on payments, but the lender has not yet taken possession of the home. During this period, the owner may be motivated to sell quickly to avoid having a foreclosure on their credit record. Pre-foreclosure purchases are typically negotiated directly with the homeowner, often as short sales where the lender agrees to accept less than the outstanding mortgage balance. Buyers can often get great value buying foreclosures at this stage, but the lender’s approval process can be lengthy.

Auction or Trustee Sale

These foreclosure listings happen when the property is sold at a public auction. These sales require cash or a cashier’s check, and the buyer has to forego a home inspection. Homes are sold “as is” with no warranties.

Buying a foreclosure home has obvious risks since you can’t inspect the interior before you buy the property. Searching for liens and other title issues is essential in this situation.

Real Estate Owned (REO)

These foreclosure homes for sale are properties that didn’t sell at auction and have reverted to the lender’s ownership. Typically, these properties are listed by real estate agents and sold in the traditional way through the MLS system.

REO properties are a good option for first-time foreclosure buyers because you can inspect them, obtain financing, and go through the normal purchase process just like any other home.

How to Find Foreclosure Listings

To buy a foreclosure home, you first need to find the listings. Here’s how to get started:

• Begin by searching the Multiple Listing Service (MLS) through a qualified real estate agent. Many REO properties appear on the MLS, where they might be identified as “bank owned,” “REO,” or “foreclosure.”
• Real estate platforms such as Zillow, Realtor.com, and Foreclosure.com have searchable foreclosure sections.
• Bank and lender websites often have dedicated pages for their REO properties.
• Online foreclosure databases and websites pull foreclosure listings from various sources. Some of these sites charge subscription fees. There are also free databases, but they tend to be less comprehensive. You can always try a free site and see how well it works for you before subscribing.
• County courthouses often publish upcoming foreclosure actions. Contact the county clerk’s office in advance to find out about schedules, procedures, and requirements for auctions. Try attending a few auctions first to see how they work before participating.
• Local newspapers and county websites list foreclosure homes for sale that are coming up for auction.
• Some real estate agents specialize in foreclosures and often have early access to foreclosure listings.

How to Finance a Foreclosure Home for Sale

Financing options to buy a foreclosure home vary depending on the stage of the foreclosure and the property’s condition.

Financing Your Foreclosure Purchase

How you finance a foreclosure home depends largely on the stage of the foreclosure process and the property’s condition.

Conventional Mortgages

For pre-foreclosure and REO purchases, you can usually get a traditional mortgage. However, the property needs to meet minimum habitability standards, including an intact roof and working utilities.

FHA 203(k) Renovation Loan

This government-backed mortgage product allows you to finance both the purchase price and the cost of repairs in one loan. This type of mortgage is ideal if you want to buy a foreclosure home that needs significant repairs.

Fannie Mae Loans

Fannie Mae offers two products that can help you buy a foreclosure home:

• A HomeStyle Renovation Loan combines the purchase price and repair costs in one loan. This type of financing can be used to buy any eligible property, including foreclosures.
• The HomePath ReadyBuyer Program strictly applies to Fannie Mae-owned foreclosures listed on their website.

Cash Purchases

Some foreclosure listings can only be financed with cash, including most auction purchases. Although you only need to deposit at the time of purchase, the balance is typically due within 48 hours.

VA and USDA Loans

Veterans can use VA loans to purchase certain foreclosed homes, provided the property meets VA appraisal standards. Foreclosure homes for sale in qualifying rural areas can be financed through USDA loans, which may offer 100% financing with low interest rates. To use USDA financing, the home must be safe and livable.

If you plan to buy a foreclosure home, get a mortgage preapproval. This signals to sellers that you’re serious about making a purchase, and it can help you move quickly in a competitive market.

Due Diligence When Buying Foreclosures

Doing your due diligence is always important when you’re buying a home, but it’s crucial for foreclosure listings because these properties often come with hidden issues. Don’t skip any of these critical steps:

• Title search: Foreclosures often come with title issues such as tax liens or second mortgages.
• Property inspection: Make sure your inspection is as thorough as possible, even if it means paying for specialized inspections. If you’re buying the home “as is,” calculate reasonable repair costs and add 20% as a contingency. Keep in mind that homes that have been sitting empty can have significant issues, such as burst pipes, pest infestation, mold, and systems that have failed.
• Occupancy status: Some foreclosures are inhabited, meaning that you’ll need to deal with evictions once you take possession. Prepare for this psychologically and budget for legal fees.
• Neighborhood research: The area of the home matters for foreclosure listings. A bargain house in a declining neighborhood may not recover its value, no matter how much you put into improvements.

Making Competitive Offers When Buying Foreclosures

Understand the motivations of the sellers to make your offer as competitive as possible:

• Banks selling REO properties are motivated to minimize their losses, but they also want to close quickly. You’re less likely to be able to negotiate, but a reasonable offer and a quick closing are attractive to them.
• Cash offers are attractive to anyone selling a foreclosure because they speed up closing and eliminate financing contingencies.
• Be prepared to offer a larger earnest money deposit than you would on a traditional home purchase. This demonstrates your commitment to go through with the deal.
• Waive or minimize contingencies wherever possible, ensuring that you still do your due diligence. Do not waive the home inspection entirely.
• Submit your preapproval letters with every offer. Preapproval letters show that you’re financially able to buy the foreclosure home, making your offer stronger.

Working with an experienced real estate agent, especially one who specializes in foreclosures, can help you put together an offer that is competitive while ensuring you get a fair deal.

Common Mistakes to Avoid When Buying Foreclosures

Typical mistakes that first-time foreclosure buyers make include:

• Underestimating repair costs: Get professional estimates wherever possible and add a substantial amount to your repair budget to cover contingencies.
• Skipping inspections: At auctions, you may need to do this, but in other circumstances, never skip the home inspection.
• Overbidding without doing the math: Don’t fall in love with the property and decide that everything will work out. Be realistic and objective when buying foreclosures.
• Ignoring title issues: Title problems are extremely common in foreclosures. Conduct title searches and purchase title insurance when you buy a foreclosure home.

Buying a Foreclosure

Buying foreclosures isn’t for everyone; It works best if you’re financially prepared for unexpected expenses, comfortable with uncertainty, and accustomed to some degree of risk. You’ll also need to be ready for a lengthy process with obstacles and delays, and you need to do the work of researching properties, markets, and neighborhoods before you buy a foreclosure.

However, you could wind up with a home at an excellent value. First-time home buyers are wise to start with REO properties and to work with a real estate agent who specializes in foreclosures.